Tax Compliance for Expats with Late U.S. Tax Filings (Examples)

Tax Compliance for Expats with Late US Tax Filings (Examples)

How to Handle Multi-Year Late or Amended Tax Filings 

IRS tax compliance is one of the most common issues for Taxpayers who are either U.S. expats living abroad or foreigners living in the United States. In an all too familiar situation, a Taxpayer will be considered a U.S. person for tax purposes but unaware that they are required to report their worldwide income on their U.S. tax return. For example, a Taxpayer may be a Lawful Permanent Resident or visa holder living in the United States while earning significant income overseas. The income is tax compliant in the foreign country but was not properly disclosed on their U.S. tax return. In addition, the Taxpayer may also have foreign accounts, assets, and investments that were not properly disclosed on the requisite international information reporting forms such as the FBAR, Form 8938, Form 3520, etc. Despite all the fear-mongering Taxpayers will find online, more often than not, it is a relatively painless process to get compliant with the U.S. government for tax-related matters. Let’s go through some of the basics by revealing some common examples.

First, Beware of Fear-Mongering, Free Consultations & False Claims of Being ‘Board-Certified’

Several times each month, our international tax law specialist team is contacted by Taxpayers who were fear-mongered into believing that they would be going to prison or even deported for failing to report their foreign income or assets. They are oftentimes also misled by the attorney they were speaking to that the attorney was a Board-Certified Tax Law Specialist when they are not. Here are a few tips:

1. 1. 1. Make sure your antenna is up when speaking on a ‘free offshore disclosure consultation’ because these attorneys will oftentimes claim to be ‘experts’ and employ fear-mongering tactics designed to unnecessarily scare Taxpayers with examples that have no relation to the caller’s  facts and circumstances.

      2. Just because the attorney claims to be board-certified, does not make it so. Some unethical attorneys falsely claim to be board certified as a tax law specialist. If the attorney claims to be a Board-Certified Tax Attorney, ask them which state they are certified in so you can confirm. Any attorney who is board-certified, even if all they practice is federal law, must be Board-Certified by at least one State Bar association. Also, just having a CPA on staff does not make a firm  a ‘Board-Certified Tax Lawyer Specialist.’

Failing to Report Foreign Earned Income

When any Taxpayer earns income in a foreign country from employment, they are required to report this employment income on their U.S. tax return:

• • • Example: Andrea is a U.S. Citizen who currently lives in a foreign country. She earns $600,000 and pays all of her foreign taxes but was not aware she was required to report this income on her U.S. tax return since she lives and works overseas. Andrea may qualify for the foreign earned income exclusion and/or foreign tax credits.

    • Example: Adam is a Lawful Permanent Resident who recently relocated to the United States. He earns consulting income from a company overseas, and the foreign company withholds taxes which are submitted to the foreign country’s tax authorities. Even though Adam is not a U.S. citizen and the income is being generated overseas (with taxes being paid to the foreign tax authorities), he is still required to report the information on his U.S. tax return. Adam may be able to apply the taxes he already paid in the foreign country against any tax liability on his U.S. tax return for that foreign income.

Failing to Report Foreign Passive Income

One of the most common international tax situations that results in the Taxpayer being out of compliance with the U.S. tax authorities is that they did not report passive income they generated in a foreign country on their U.S. tax return:

• • • Example: Brian is a U.S. Person who lives in the U.S. but earns interest in his foreign accounts. The interest income is not taxable in the country where the interest is earned. He is still required to report the interest on his U.S. tax returns.

    • Example: Brandon is a U.S. Person who owns real estate in a foreign country. The income is taxable in the foreign country and he pays all the taxes to the foreign government. Brandon is still required to report the real estate income on his U.S. tax return.

    • Example: Brittney earns dividends form her foreign investments. The dividends are for foreign investments and the income is not transferred to the U.S. The dividends are still reportable on a U.S. Tax Return.

Unreported Foreign Accounts

In addition to having to report foreign income, U.S. persons with foreign accounts, assets, and investments abroad are required to disclose this information to the United States government on various international information reporting forms each year such as the FBAR and Form 8938:

• • • Example 1: Michelle lives in a foreign country and has five different bank accounts. Some of the bank accounts are above $10,000 and some of the bank accounts are below $5,000. Since the aggregate annual total of the foreign accounts exceeds $10,000, all 5 bank accounts are reportable on the FBAR. For Form 8938 purposes, even though Michelle files as “Single” on her tax return and the maximum value of her accounts combined in the year was $170,000, she does not have to file the Form 8938 (since it is under the threshold reporting for foreign resident Form 8938 filing).

    • Example 2: Janine lives overseas and has three bank accounts with a total maximum value of $340,000. Janine also files as “Single” on her tax return, but because the maximum value of her foreign accounts exceeded $300,000 during the year, she will file both the FBAR and Form 8938.

    • Example 3: David lives overseas and has one bank account with $700,000 and no income from any sources. David will file the FBAR, but since David is not required to file a tax return, he does not need to file Form 8938 even though the maximum value of his account exceeds the filing threshold for Form 8938.

Foreign Mutual Funds and ETFs

Unfortunately, in most situations, foreign mutual funds and foreign ETFs will qualify as PFICs — Passive Foreign Investment Companies. As a result, the Taxpayer may be required to file multiple forms each year depending on how the pooled funds are held and whether they are held directly or in a foreign account with other non-PFIC:

• • • Example 1: Scott owns $370,000 in foreign mutual funds (directly) and ETFs in an investment account. Therefore, Scott will have to file the FBAR along with a separate Form 8621 for each PFIC.

    • Example 2: David has an investment account worth $900,000 with 9 mutual funds within that investment account with a value of $600,000. In this type of situation, David will have to file the FBAR to report the foreign account, along with Form 8938 to report the foreign account — as well as individual Form 8621s for each PFIC. That is because even though there are mutual funds in the investment account, there are also non PFICs which will mandate the filing of both Form 8938 and 8621.

    • Example 3: Peter has an RRSP that contains multiple foreign mutual funds in it with a value of $400,000. Peter will have to file the FBAR and Form 8938 but may be able to avoid filing Form 8621 for the mutual funds by relying on the PFIC treaty exception.

Unreported Foreign Gifts or Inheritance

When a U.S. person receives a gift or inheritance from a non-resident alien and the total value of the gift or inheritance in the year exceeds the threshold requirements, the Taxpayer may be required to file a form 3520 and/or form 3520-A to disclose this information to the U.S. government:

• • • Example: Dana is a U.S. Citizen but the rest of her family are non-resident aliens who live abroad. Her aunt is very proud that Dana graduated college and gifted her $400,000 to help her purchase a new home. Dana may have to file Form 3520.

    • Example: Devin is a Lawful Permanent Resident who currently attends school in the United States. Devin’s grandma is a non-resident alien who wants to help Devin with expenses — and gifted him $200,000 to help him supplement his expenses. Even if Devin does not use all the money for expenses, his grandma made it clear that the full amount is a gift to Devin. Devin may have to file Form 3520.

    • Example: Denise’s mom is a non-resident alien who wants to gift Denise and her sister each 15% in a foreign business. The value of the shares that Denise receives are $500,000. Even though Denise did not receive money, and the business is located outside of the United States, she may have to file Form 3520.

    • Example: Daniel is a visa holder who meets the substantial presence test. His dad gifted him a foreign rental property worth $600,000 so that Daniel can both own the property and collect any rents that are paid. Even though the rental property is located outside of the United States, Daniel still received a gift from a non-resident alien and may have to file Form 3520.

Unreported Foreign Trusts

Taxpayers with ownership or other interests in a foreign trust are typically required to report this information to the U.S. government on forms 3520 and 3520-A. If the Taxpayer also receives a distribution from the foreign trust then additional reporting on form 3520 may be required:

• • • Example: Denise is a U.S. Citizen who has non-resident alien family members living abroad. Her sisters — who are all non-resident aliens– decided to form a foreign trust and wanted to include Denise as one of the owners. Now that Denise is an owner of the foreign trust, she is required to report her ownership on form 3520 and 3520-A.

    • Example: Daniel is a Lawful Permanent Resident who recently became a U.S. person in the current year. Now that Daniel is a Lawful Permanent Resident and a U.S. person for tax purposes, his ownership in his foreign trust is reportable on Form 3520 and 3520-A (U.S. owner of a foreign trust). In other words, even though the only action Daniel took was to become a U.S. person, his previous ownership in a foreign trust that he owned before becoming US person is now reportable.

Unreported Foreign Business

When a Taxpayer has an ownership interest in a foreign entity, they may be required to disclose this information to the U.S. government. Depending on the total value of their ownership and the percentage of ownership they (and other U.S. persons have) may impact the disclosure requirements:

• • • Example: Sam became a U.S. person and is a 100% owner of a foreign company. The company is considered a controlled foreign corporation since Sam is a U.S. shareholder and U.S. shareholders in total own more than 50% of the company. Sam may have to file a form 5471 but may qualify to report it as a disregarded entity.

    • Example: Samantha became a U.S. Person but still has family members overseas. Her grandma decided to distribute shares of her foreign company to her grandchildren and Samantha receives a 14% ownership in the foreign company. Samantha may have to file a Form 5471.

    • Example: Scott relocated to the U.S. and has 15% ownership in a foreign company owned more than 50% by U.S. persons. Scott had control of the company in the current year and the foreign corporation runs on the same tax year as Scott. He may have to file a Form 5471.

Late- Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.